Understanding the Control Environment

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When trying to deter fraud, most companies focus their time on developing effective internal control procedures and segregation of duties.  Though developing these types of systems are important, a common element of the COSO Internal Control Framework that is often overlooked is the organization’s control environment.

The control environment is important to all organizations since it is the first element of the COSO Internal Control Framework and, more importantly, the foundation of the internal control structure.   The control environment, which has also been described as the “tone at the top” includes management’s integrity and ethical values, management’s philosophy and operating style, and the oversight provided by the board of directors. Many times managers and owners set the control environment for their organization by their actions and thought process without even knowing it.  For instance, if a manager is reluctant to follow company policy or consistently demonstrating the quality of getting ahead no matter what the cost, then the manager may be inadvertently influencing the company’s culture and enticing employees to do the same.

To ensure that the control environment is acting as a solid foundation for internal control matters, management should consider the following:
• Develop and implement a code of conduct that states what is regarded as acceptable business practices
• Maintain high ethical expectations with employees, suppliers, customers, investors, competitors, and others.  Ethical behavior at the top permeates down throughout the organization.
• Be wary of placing undue pressure on employees to meet unrealistic performance targets, especially for short term results.
• Develop formal job descriptions to define the tasks of a particular job.
• Ensure that the board of directors, if any, exercises oversight relating to financial reporting and internal control.

By setting the tone of the organization’s control environment, managers are able to influence the consciousness and the moral compass of the rest of the organization in an inexpensive yet very powerful way. 

Danny Oertle